Angel investing

In short

You have probably heard someone say they got in early on a company that later became a household name. That is angel investing in one sentence. An angel investor puts personal money into a very young business, usually before any bank or big fund will touch it. The founder gets cash to keep the lights on. The angel gets a share of the company in return. It is a high risk bet, and you should know that going in.

The whole of it

What it is

A friend of mine once described angel investing as lending your umbrella to someone who swears the sun will shine. You give real money today for a promise of future value. The business is usually tiny, maybe just two people and an idea. The word angel came from Broadway, where wealthy patrons funded shows that no theater would back. It stuck because the money often feels like a gift with a hope attached. You become a part owner of the company, holding what is called equity, meaning a slice of whatever the business is worth.

How it works

I once watched a young woman pitch her idea to a room of investors with nothing but a napkin sketch and honest conviction. That is often how it starts. A founder needs money before a bank will loan it and before a venture capital fund, which is a large pool of outside money managed by professionals, will bother to look. You write a check, usually directly to the company. In exchange you receive either common stock, which is a basic ownership share, or something called a convertible note, which is a loan that later turns into stock at a set price. The terms get written into a short contract. From that point on your money is locked inside the company. You cannot sell your shares on a stock exchange the way you can sell Apple or Ford. You wait. You might wait five years. You might wait ten. The money comes back only if the company gets bought, merges with another firm, or sells shares to the public in what is called an IPO, short for initial public offering. If none of those things happen, you may get nothing back at all.

The numbers, and where to find yours

If you are holding a paycheck and wondering whether this is open to you, the honest answer is that it depends on one legal concept. The SEC, which stands for the Securities and Exchange Commission, has a category called an accredited investor. That status is the door to most angel deals. The SEC sets the income and net worth thresholds, and those figures live on the SEC's official website at sec.gov. The SEC publishes investor guidance on accredited investor status there, and you should read that page directly rather than trusting any third party summary, including this one, for the exact current numbers. The thresholds are [rule:accredited investor income threshold] in annual income or [rule:accredited investor net worth threshold] in net worth, not counting your primary home. The SEC also recognizes certain professional certifications as a path to accredited status. As for how much money a deal might ask you to put in, that figure varies widely and is set by the company and its founders, not by any government rule. The company's own term sheet, which is the document spelling out the deal, will state the minimum investment required, and that is the number you should look at first.

A worked example

Say you meet Rosa, a software developer who left her job to build a scheduling tool for small dental offices. Rosa needs 300,000 dollars to hire one engineer and run the product for eighteen months. She is not profitable yet. She has no revenue. But she has twelve dental offices already interested, and she has been working on this for two years without pay. A small group of five angels decides to back her. You put in 25,000 dollars. The total raise is 300,000 dollars. The deal is structured as a convertible note with a valuation cap of 3,000,000 dollars. That cap matters a lot. It means that when a bigger investor comes in later and values the company at, say, 6,000,000 dollars, your note converts to stock at the lower 3,000,000 dollar cap. You get twice as many shares as someone who invests at the higher price. Two years pass. A regional health tech company offers to buy Rosa's business for 9,000,000 dollars. Your 25,000 dollar note, now converted to equity at the cap, represents a little under 1 percent of the company. One percent of 9,000,000 dollars is 90,000 dollars. That is your gross return before taxes and any fees. It is not guaranteed. Rosa could have run out of money at month fourteen. That is the real risk.

Where it goes wrong

I once knew a man who put money into six startups and said afterward that five of them taught him everything he knew. He was not bitter about it. He was honest. Most early stage companies do not survive. They run out of cash. They pick the wrong market. The founder burns out. Or the product works fine but no one wants to pay for it. Your money is illiquid, meaning you cannot get it out when you need it for something else. Fraud is rare but real. The SEC's EDGAR database, at sec.gov, lets you check whether a company has filed the required disclosures. If a deal is not registered and does not qualify for a legal exemption, that is a warning sign worth stopping for. Conflicts of interest happen too. A founder might promise terms to one angel that differ from what another angel receives. Read every document. Ask a securities attorney, meaning a lawyer who focuses on investment law, to look at the term sheet before you sign. That fee is small compared to the check you are writing.

Questions to answer before you leave this page

Before you take a single step toward an angel deal, sit with these questions for a while: Do you meet the SEC's accredited investor definition as it currently stands on sec.gov, and have you read that page yourself rather than relying on someone else's word? Can you honestly afford to lose every dollar you put in without it changing your life in a painful way? Do you understand the specific structure of the deal, meaning whether it is equity, a convertible note, or a SAFE (which stands for Simple Agreement for Future Equity, a standard short form contract often used in early deals), and do you know what happens to your shares if the company raises money again at a lower value than you expected? Have you looked at the founders themselves, not just the idea, and do you believe they will still be working on this in three hard years when things are not going well? Do you know how and when you might ever see your money again, and have you asked the founder directly what the exit plan is? Have you had a securities attorney look at the paperwork, and if not, what is stopping you from making that one phone call before you sign?